Statistical Summary
Current Economic Forecast
2007
Real Growth in Gross Domestic Product (
Inflation: 2 - 2.5 %
Growth in Corporate Profits: 5-7%
2008
Real Growth in Gross Domestic Product (GDP): 3-3.25%
Inflation: 1.75-2%
Growth in Corporate Profits: 7-9%
Current Market Forecast
Dow Jones Industrial Average
2007
Current Trend:
Medium Term Uptrend 12626-14189
Long Term Uptrend 11400-23400
Year End Fair Value: 13000
2008 Year End Fair Value: 14000
Standard & Poor’s 500
2007
Current Trend:
Medium Term Uptrend 1449-1585
Long Term Uptrend 1225-2400
Former Long Term Trading Range 750-1527
Year End Fair Value: 1500
2008 Year End Fair Value: 1625
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 10%
High Yield Portfolio 37%
Aggressive Growth Portfolio 14%
Economics
The economy is a positive for Your Money. This was another of those weeks with not much economic input and what there was we would characterize as mixed.
(1) the housing data was mixed with weekly mortgage applications rising 1.1% offset by the National Association of Realtors once again lowering its estimate for 2007 existing home sales,
(2) retail sales weren’t much better. The International Council of Shopping Centers [ICSC] reported weekly sales of major retailers up .1% and up 2.4% on a year over year basis; however, Redbook Research reported month to date retail chain store sales fell 1.3% versus the comparable June period though they inched up .8% on a year over year basis.
In addition, June retail chain store sales [reported Thursday] were better than estimates though [a] those expectations were admittedly modest and [b] several retailers reported disappointing results. We actually were somewhat surprised by these results given the lousy weekly sales numbers that were reported by ICSC and Redbook in June.
However on Friday those poor weekly sales figures manifested themselves when total June retail sales were reported down .9% versus expectations of an increase of .1%; ex autos, sales were down .4% versus expectations of a .2% rise.
Both June reports were overshadowed by the University of Michigan preliminary July index of consumer sentiment of 92.4 versus expectations of 86.0 and the 85.3 final June reading.
Netting all this out and taking into consideration the positive May consumer income and spending numbers reported last week, the consumer still appears to be alive and well though the grim news from the housing market plus higher gas prices is perhaps making them a bit more circumspect in their spending.
(3) on the other hand, the business sector continues to rebound. May wholesale inventories rose .5% versus expectations of an increase of .4%; however, wholesale sales were reported up 1.3% which puts the wholesale inventory to sales ratio at 1.1 month, a record low.
In addition, May business inventories rose .5% versus expectations of an increase of .3%; and like the wholesale numbers, business sales jumped a stronger 1.3%, pushing down the inventory to sales ratio.
(4) employment remains strong as weekly jobless claims fell 12,000 versus expectations of a decline of 6,000.
(5) in the government sector, the Administration lowered its estimates of the 2007 fiscal year budget deficit from $248 billion to $205 billion. Meanwhile, the Congressional Budget Office forecasts the deficit will come in at $172 billion. We have been critical of the lack of fiscal spending discipline by W and the congress--that hasn’t changed. But credit has to be given to W for his tax cuts and the benefits that they have brought to the economy.
The May trade deficit was reported at $60 billion in line with expectations. Oil imports were a primary reason for this number remaining so high.
The bottom line is that we continue to believe that the economy is in or passed a ‘soft’ landing and that inflation is moderating. That forecast could stand even if we receive a few more weeks of lousy housing data and have to conclude that the bottom has not been reached--because as you know, weak housing has always been part of our forecast. On the other hand, it would certainly raise the probability that we may have to lower our 2007 economic growth estimate depending on how the other areas of the economy perform.
Right now, based on the last month’s erratic retail sales and consumer spending numbers, continued weakness in the consumer sector would be the most likely cause of that downward revision. Specifically, if spending either remains mixed for an extended period of time or weakens short term, we will likely have to lower our 2007 forecast for economic growth. We clearly can’t predict whether or not either will happen; though on a positive note, we remind you that a couple of months ago we went through the same exercise with industrial activity--remember there was a month or so of mixed news from the business sector and we thought that if it continued, our present forecast would be in jeopardy. Then the economic reports turned uniformly positive and our concerns were assuaged. We are not predicting that this same pattern will occur in consumer spending, just pointing out that in a ‘soft’ landing there is an increase in the volatility of reported economic results which doesn’t necessarily lead to a decline in the overall level of economic activity.
The Economic Risks:
(1) the economy is weaker than expected.
(2) Fed policy (reading the data correctly).
(3) a disruption in global oil supplies (It is not the price of oil but its availability that will cause severe economic dislocation.).
(4) protectionism (Free trade is a major positive for world and
(5) fiscal profligacy (Government spending as a percent of GDP is too high and the looming explosion in entitlement expenditures will make it worse. There is no good solution save spending discipline.).
(6) a rising tax and regulatory burden (Government has never proven that it could solve economic problems efficiently or satisfactorily.)
Politics
We remain convinced that both the domestic and international political environment is a negative for Your Money; though at the moment, it is clear that once again investors not are factoring these considerations into equity valuations. The dominating political news this week was the weakening resolve of Senate Republicans on
http://www.washingtonpost.com/wp-dyn/content/article/2007/07/12/AR2007071201619.html
The Market
Technical
The DJIA is in an up trend defined by the approximate boundaries of 12626 and 14189. If the S&P can remain above the 1527 level (which it looks like it will this time), its up trend is defined by boundaries of roughly 1449 and 1585. They will remain in those up trends until they are not.
Fundamental
The notable events this week were (1) a spike up in concern over the sub prime market, then (2) a total reversal of sentiment after several large buyouts were announced late in the week and investor attention re-focused on the strong global economy--very similar to the sentiment that fueled the moon shot that began during the first quarter earnings season. Stock valuations pushed into over valued territory as investors seemed to rationalize mediocre retail sales as a positive and to ignore any residual (?) problems in the sub prime Market or the domestic/international political environment--and that sent short sellers scampering to cover.
Will stock prices resume the Titan III formation that they were in earlier this year? Is this the beginning of a second leg where investors ignore fundamentals and push equity prices to record levels? Clearly our Valuation Model argues against that--but as we noted amidst the first quarter moon shot, during rapidly accelerating up moves fundamentals are a secondary consideration. That said, one of the major functions of our Valuation Model is to prevent us from getting caught up in popular sentiment at Market extremes, even though it almost guarantees that there will be a period in which we look stupid for investing against the trend. But that is a necessary, perhaps the critical, element of our Valuation Model/Price Discipline.
Given that somber note, it may likely raise the question as to why so many stocks went on our Buy Lists Thursday in the face of the huge UP day in the Market (especially when we could have acted on Tuesday after the sell off). The short answer is that this week we began the periodic (once a quarter) process of up dating the prices in our Valuation Model for the stocks in our Universes. This is a very time consuming process and our habit is to focus solely on getting the task done as quickly as possible to the exclusion of virtually everything else. Unfortunately, Thursday’s Market caught us in the middle of the process. We made the decision mid day to halt the revaluation process and focus on the new values of those stocks for which we had completed the valuation process (we have since resumed the process).
Why is that important? Because since our investment strategy focuses on companies with growing dividends and earnings, then for most stocks (we won’t go into the exceptions in this discussion) that means that these periodic revisions will result in an upward shift in the boundaries of their Buy Valuation Range and hence in their Buy Price, Stop Loss, Sell Half Price--and for rapidly growing companies, this upward shift can be pronounced.
So long story, short on Thursday we found a number of companies whose Buy Value Ranges had shifted upward sufficiently to bring the stocks at their current price back into their respective Buy Value Ranges (typically that means that while these stocks’ prices are up, they are lagging).
The bad news is that as much as we have tried to automate this process so that it could be continuous and thus prevent these kinds of problems, there are enough judgment calls involved that each company/stock requires individual attention.
The good news is that as this process lifts the Buy Value Range, it also raises the Stop Loss and Sell Half Prices assuring us that (1) in the case of a stock that trades down, we are stopped out at an ever increasing price (e.g. our cost in CR Bard is $21.81, our current Stop Loss is $40) and (2) we take profits at ever increasing levels (e.g. in our latest review, our Sell Half Price for Exxon went from $90 to $112).
And yes, we looked at the Valuation Model of the Market indices; and yes, we may raise our 2007/2008 Year End Fair Value. Whether or not we do so depends on the extent to which this new concept of the ‘global impact on the
If we have totally confused you, send us an email with any questions and we will do our best to answer them.
Our current investment strategy remains to
(1) pay close attention to our Price Disciplines in particular our Sell Half Prices
(2) as a corollary, use the present heightened volatility to our advantage by taking profits when prices spike to the upside and buying the stocks of great companies when opportunities present themselves,
(3) continue to focus on improving the quality of our Portfolios by Selling the stocks either of companies that fallen below the minimum standards of our Quality Discipline or that have performed poorly over an extended period.
(4) insure that our Portfolios can ride out any turmoil brought on by trouble in the sub prime market [we don’t believe this problem has gone away].
DJIA S&P
Current 2007 Year End Fair Value 13000 1500
Fair Value as of
Close this week 13907 1552
Over Valuation vs. 6/30 Close
5% overvalued 13387 1544
10% overvalued 14025 1617
15% overvalued 14662 1690
20% overvalued 15300 1764
The Portfolios and Buy Lists are up to date.
Company Highlight:
The 3M Company (formerly Minnesota Mining and Manufacturing) is a broadly diversified manufacturer of industrial, health care, graphic and display, office, communications, transportation, and safety and security products. In recent years, the company has enjoyed a resurgence of growth in sales and profits as its health care and graphics businesses expanded at an above average pace. The company has an amazing 30% return of equity with a debt to equity ratio of only 15%. Earnings have grown at a 9-10% annual rate over the past 10 years. While dividends have not kept pace as the company reinvested cash flow in new businesses, we expect the dividend pay out ratio to increase in the next several years.
EPS: 2006 $5.06, 2007 $4.85, 2008 $5.05; DVD: $2.00, YLD 2.4%
http://finance.yahoo.com/q?s=MMM
Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 38 years of investment experience includes institutional portfolio management at Scudder. Stevens and Clark and Bear Stearns, managing a risk arbitrage hedge fund and an investment banking boutique specializing in funding second stage private companies. Through his involvement with Strategic Stock Investments, Steve hopes that his experience can help other investors build their wealth while avoiding tough lessons that he learned the hard way.
